In Mammon Among Friends, Malcolm C. Harris, Sr. provides commentary and news about the national economy, the Wichita economy, the world of finance, and postal economics. Experiences such as forecasting postal volumes and revenues, being involved in utility regulation, and teaching corporate finance have shaped his analysis.

Tuesday, June 30, 2009

Thursday will bring two big releases of national economic data with significant implications for the Wichita economy.

9:00 A.M. Central Daylight Savings Time:The Bureau of Economic Analysis (of the Commerce Department) will issue data for May manufacturing orders, shipments, backlogs, etc. While total new orders are an important cyclical indicator, we in Wichita will be particularly interested in the new and unfilled orders for the aerospace industry. This will not include the impact of Quantas' recent cancellation of orders for 15 Dreamliners.

7:30 A.M. Central Daylight Savings Time: The June employment report. Normally this would be issued Friday, but the Bureau of Labor Statistics is moving it up a day for the Independence Day holiday. The consensus of forecasts is that it will show aloss of 350,000 jobs on nonfarm payrolls and the unemployment rate up to9.6 percent.

What to look for: A better showing on job losses would support our thesis that the economy has bottomed out. Even without a significant surprise from the payroll data, the report may better expectations on the unemployment rate which is based on the notoriously noisy household survey. The household survey also gives an alternative measure of employment. Analysts tend to ignore this measure for techical reasons, however I have found a careful analysis of these data gives better signals at turning points. By this metric the decline in employment has moderated even more than manefested on the establishment survey. Look for further confirmation of bottoming out. The non aerospace component of Wichita's economy needs to see a pickup in activity in the national economy.

Friday, June 26, 2009

Mr. Zhou Xiaochuan, is the People's Bank of China's Governor and Chairman of the Monetary Policy Committee. He published a paper on March 23, 2009 calling for increased use of the SDR as a reserve currency. Read Governor Zhou Xiaochuan's call to "Reform the International Monetary System" on the Bank's web site.

How bad is it that we are no longer the Masters of the Universe? It is not that long ago that Japan had eight of the ten spots on that list. The result? The next ten years were a lost decade for the Japanese economy. Is this just another example of post hoc, ergo propter hoc (the logical fallacy of "after this, therefore because of this)? Japan had a bubble because of a huge overexpansion in credit, foreign financed after financial deregulation. Inflated capital led to overexpansion of banks and a monster bubble. Bubbles burst. Bubbles distort incentives and misallocate resources. Like inflation, bubbles are bad and are caused by bad policy.

The United States has suffered from a virulent form of the Dutch disease these last twenty years. As Wall Street has sucked in capital from all over the world, manufacturing has been hollowed out. As value added in the financial sector grew, our competitiveness waned.

The White House White Paper is largely ratifying reality. (See below and today's Eagle: "New financial rules explained.") The more prudent banks (JPMorgan, Intrust) will prosper. The others have been shrunk in true capitalist fashion. If the financial sector shrinks, so be it.

Monday, June 22, 2009

Numbers guys you can count on

I have hired quite a few finance directors over the years. Some were outstanding; others did not work out so well. Inevitably, I have acquired some views about what makes a great numbers guy.

I prefer working with someone fundamentally conservative. Bullish chief finance officers are dangerous. The leader of a business needs to be an optimist, and sales-oriented. But every business needs at least one person at the top alongside them to worry about the downside. I insist that the senior finance person is a qualified accountant. Whether they are a certified public accountant or a chartered accountant, they will have been taught how vital prudence is when preparing accounts, budgets and so forth. I am always astonished at how huge US corporations, like Enron and leading investment banks, can hire go-go MBAs as their CFOs. No wonder they got into trouble.

The CFO must be able to assemble and analyse financial statements themselves: I do not want a quick-talking professional who has risen so far that they do not understand the business’s accounting systems. But they must also be able to see the whole picture and not get so immersed in detail that they overlook major issues – a surprisingly common failing.

The CFO must also be able to explain treatments, policies and consequences so that every executive can understand them. The best accountants do not hide behind jargon or technical mumbo-jumbo. Great accountants are so familiar with the company’s books that they can swiftly identify each entry, liabilities and assets, every item of income and expense, flows of cash, margins and all the rest, where material.

Some CFOs get bored with things like management accounts, and really want to be corporate financiers. They would rather be doing deals, having power lunches and indulging in the whole merry-go-round, rather than crunching the numbers. Those tasks have their place, but they are not the first order of business. Principally, the CFO must be in absolute command of the figures and financial basics, such as tax, debt and key ratios. Only once they have total mastery of vital administration should they be thinking about the sexy stuff like M&As.

As well as highly numerate, a modern CFO must be something of an IT expert. There are still a surprising number of finance professionals who struggle to use even unsophisticated accounting software. It must be a devastating disadvantage for anyone performing a high level finance job in the 21st century. Similarly, a rounded CFO will have a thorough knowledge of property – leases, financing and the rest – and insurance, as well as a good grounding in corporate law and company secretarial affairs.

The best CFOs have a close, mutually respectful, but not subservient relationship with the chief executive. Those who never disagree and do not stand up to their boss on key matters are not worth having. Ultimately, shareholders and the board place huge faith in the CFO. Whoever fills the post must be independently minded and a strong enough character to deliver the truth to the owners and non-executives – no matter how unpalatable. While every CFO should be a partner to the CEO, they should always believe they report to the board and owners of a corporation.

As with every senior role, an ability to manage people and a sense of humour are critical. But with a CFO, absolute integrity and a capacity for hard work are even more important. During difficult times the role cannot be executed in 40 hours a week and a holiday entitlement of six weeks. Periods of crisis call for all hands to the pump. CFOs are the ones who are managing costs, coping with foreign exchange risks, dealing with pressing bankers and covenants, collecting overdue money and ensuring the auditors do not qualify the accounts. A proper company cannot function without a decent finance director at the helm, supervising, informing and warning.

They may not win all the applause as corporate heroes, but without their contribution even the sexiest business would soon be in trouble.

Friday, June 19, 2009

During the bubble years, we worried that investment banks got overlevered running up leverage ratios (ratios of assets to equity) of thirty and forty times. We all know what happened then.

The Federal Reserve Bank of New York's Consolidated Balance Sheet shows its leverage ratio was37.5 timesat year end 2007. Its President in 2008 was a Timothy Geitner (now Secretary of the Treasury.) At the end of 2008, the Fed of New York achieved a leverage ratio of112.5 times.

Maybe their old boss can bail them out if they go bust now that some banks are buying back TARP stock.

Thursday, June 18, 2009

Yesterday in a series of public interviews and announcements, the administration in Washington put forth its proposed reform of U.S. financial regulation. The proposal itself is embodied in an 89 page White Paper, "Financial Regulatory Reform: A New Foundation." It is a combination of the "art of the possible," America's penchant for committees, and ratification of the de facto reality.

Otto von Bismark declared, "Politics is the art of the possible." President Obama is realistic about what he can get through Congress and what he can not. Simplifying and consolidating the patchwork quilt of prudential and financial services regulation would provoke a huge turf war that would stall this legislation and much of the rest of his agenda.

The Fed is a big winner. It gains authority to regulate any firm which is a systemic threat to the financial system. A GE Capital or an American Express could come under its prudential regulation if it is big enough and/or interrelated enough to be a source of systemic risk. The New Deal left investment banks largely outside the circle of prudential regulation. The financial crisis drove the main investment banks either out of business or into bank holding companies as permitted under Gramm-Leach-Bliley. Thus the remaining major investment banks are already under the Fed's regulation. Other large or potentially system threatening firms could be designated "Tier 1 Financial Holding Companies" (Tier 1 FHCs) even though they do not hold subsidiaries that issue deposits. Importantly the Fed will regulated these Tier 1 FHCs on a consolidated basis. Bear in mind that the Fed is the only agency that has the firepower to deal with systemically threatening businesses.

Although the Fed will be the prudential regulator for Tier 1 FHCs, it is not clear who will put up the capital for non banks that need to be resolved in a liquidation. It appears the Treasury is to resolve these situations, but will it require a prior Congressional appropriation such as TARP did?

It looks like Tier 1 FHCs will be required to hold to more stringent capital requirements. It is not clear whether that is more stringent that non Tier 1 FHCs or more stringent than pre-crisis requirements.

The Treasury will chair a Financial Services Oversight Council. The Office of Thrift Supervision disappears, but there will be a new Consumer Financial Protection Agency.

Securitization and such derivatives as Credit Default Swaps were at the heart of the financial crisis. Firms issuing securitized obligations will have to have some "skin" in the game much like European income bonds or the Federal Home Loan programs. Excellent idea!

The proposal calls for more comprehensive regulation of derivatives. I will need to dig into the details before I can determine how much beef there is in the rhetorical receipe. The Fed gains authority over "systemically important payment, clearing, and settlements systems."

The split in authority between the SEC and the CFTC continues, but the Financial Services Oversight Council can adjudicate disputes. Will it intervene when neither does its job? Remember Enron?

Some thoughts:

Bigger capital requirements on the big boys is effectively a tax on their ROE. It is not necessarily a bad thing that Wall Street shrinks and the small fry gain, but Wall Street has its lobbying clout to be delt with.

The proposal seems to call for a pullback from Basel II and greater capital requirements for risky assets. At the same time it calls for "a simple, non-risk based capital measure to limit the amount of leverage built up in the international financial system." This sounds like squareing the circle to me.

There is a call for less procyclical capital requirements. Spain is the star in this credit crisis. By adopting capital requirements that go up in a boom and are smoothed in a bust, Spain's banks (much like Brazil's) come out of the crisis is relatively good shape. Spain was not saved from a housing bubble, however. It would be impolite to point out that the Fed, the White Paper's big regulatory winner, caused the bubble in the first place.

There are considerable words about firm value accounting and transparancy. The White Paper requires that accounting be looked into again. I seem to remember that mark to market accounting was at the heart of the Enron debacle. Enron and WorldCom led to financial institutions' being subject to greater market to market accounting. Those commissioned to look into these issues will find the conflict between fair market accounting and banks' function of intermediation illiquid loans a difficult nut to crack.

Monday, June 15, 2009

Rebecca Smith and Ben Casselman report in the Wall Street Journal that falling natural gas prices are gaining it market share in the electricity market at coal's expense. There appears to be a non zero cross price elasticity between coal and natural gas in this market. No doubt there is more in the longer run than the shorter run.

In today's Wall Street Journal, Kathy Chen reports, "Post Office Looks to Scale Back." Faced with a shocking fall in mail volumes (according to Ms Chen it is down 32 billion pieces in two years), the Postal Service finds one congressional road block after another in the way of reducing costs or increasing revenues.

He who calls the tune (Congress) does not pay the piper. The Service runs on its own revenues as a business, but Congress still restricts what they can do even though it does not pay for the Postal Service.

Arguably the Postal Service is a natural monopoly in a declining cost industry. Milton Friedman used to argue there are three solutions to the problem of monopoly: government ownership, regulation, or doing nothing. He always favored the last. The Postal Service has the worst of both worlds: it is both government owned and regulated. They are regulated even though it is not a private company.

Congress made matters worse when it changed the Postal Service's controlling legislation. It restricted its entering new businesses, restricted its price increases to inflation or less, and required it to prepay its retiree health benefits without tying the payments to changing actuarial costs. If Ford lays off workers, it reduces its future retiree health benefits. If the Postal Service cuts its workforce, Congress does not reflect the cuts in its annual bill.

Free the Postal Service up so it can compete. UPS's virtual monopoly in ground parcels (particularly BTB) and its price discrimination are not healthy for the U.S. economy. The customers of UPS and FedEx would benefit from more competition.

Congress's micromanaging of the Postal Service foreshadows what is in store for bailed out firms. Citi, GM and Chrysler will find government control and Congressional tinkering far more onerous than governmental ownership itself. As a shareholder in Ford and JPMorgan, I am happy to see both free of the TARP ball and chain.

Friday, June 05, 2009

The May establishment survey shows 345,000 fewer jobs than in April. That is bad and makes my assertion that March was the recession trough look a little shakier. Still after the massive losses we saw over the last few months, it looks like an improvement.

The Bureau of Labor Statistics also surveys households. This survey shows an even bigger drop in the number of Americans who say they have jobs: 437,000. Remember that the household survey actually showed an employment increase (yes, I said an increase) in April and that this survey is subject to greater month to month sampling variation than the establishment survey. It also does not have the contemporaneous biases caused by the firms births/deaths adjustment process.

The headline news is the jump in the unemployment rate from 8.9 percent (compared to Wichita's 7.1 percent) in April to 9.4 percent in May. This is the worst since the early 1980s. (Unemployment hit a peak of 10.8 percent in November and December, 1982.)

How did the unemployment rate go from 8.5 percent two months ago to 9.4 percent?

The biggest driver is an increase in the work force of over a million in those two months. More people are looking for jobs.

Why? Hard times force more people into the work force. Most of the increase is among men and teenagers. This increase might reflect high school students and graduates looking for jobs sooner than the BLS's statistical adjustment assumes they do. There was a 536,000 increase in the workforce among those with no or only high schooling. The minimum wage increased last July and is slated to do so again next month. As often happens when the minimum wage goes up, the unemployment rate rises among minority teenages. It is now close to 40 percent for Black teenagers.

Wichita

It looks like employment fell another 7,000 jobs in the aircraft industry. Still now there may be more jobs in aerospace than in the automotive manufacturing.

In the fourth-quarter, Australia's GDP dropped 0.6%, the first drop in eight years. Apparently the Aussie national income accountants do not report growth rates in seasonally adjusted annual rates annualized. It makes the numbers less dramatic.

Disclosure: your correspondent has shares in an Aussie closed end fund.

What does it mean?

Australia's economy is tied to Asia. When the Chinese dragon stokes up its furnace, Australia and Brazil feed the beast the inputs that fuel its exuberance. Thus Australia's economic growth and the Aussie dollar are leading indicators of the globalized economy.

This implies that the world economy is recovering. Further dramatic confirmation can be found in the Baltic Dry Index, an indicator of shipping prices. As trade picks up, it costs more to hire a ship to transport it. The index has increased four-fold since December returning to the boom levels of 2004-6 and soaring toward the bubble levels of mid-2008.